Capital Gains Loophole You Should Know About

Did you know that if you have an investment property you want to sell, but you don’t want to pay taxes on the capital gain, you can do what’s called a “1031 Exchange” and have the taxes deferred?

That nice ol’ government agency that we all know and love — the IRS — allows you to exchange one investment property for another and defer the capital gains taxes while doing so.

It’s easy to do a tax-free 1031 Exchange with Guardian, even within the complicated systems of the IRS.

The 1031 Exchange is an extremely powerful wealth-building tool that not enough people know about or use to their advantage. Typically, the greatest expense you face with investments is the tax, which can drastically erode your wealth. I’m sure I don’t have to tell you this, but: avoid paying taxes whenever legally possible!

Not sure if you can do a 1031 Exchange? Let’s go over some scenarios that might relate to you.

Do you own, or have you inherited, a rental home, vacation home that has been rented, townhome, condo, commercial building, vacant plot of land, shopping center, parking lot, or anything that would be considered investment property? Real property (that is not your primary residence) can be sold and exchanged free of any capital gains taxes through a 1031 Exchange. The one caveat is that you can never take possession of the proceeds from your sale. Prior to closing on the sale, you would need to contract with a 1031 company.

Here’s a more specific scenario. Let’s say you bought a home 20 years ago and although renters have come and gone, it has always been a rental. You’ve had to manage, repair, maintain, and occasionally carry the rent over the past 20 years, but overall, it has been a good investment.

You are ready to stop being a landlord, but you feel stuck: You know that if you sold it, you would have to pay taxes on the capital gain, and you would have a bunch of money sitting around not making any return for your portfolio. If you were to sell and exchange it for another rental, what would you accomplish? Nothing. I’m guessing you probably don’t want to own vacant land or a commercial building, either.

The good news? There is an easy solution. You can sell your property and exchange it for Guardian Homes. And yes, you can literally exchange your one home for multiple Guardian Homes. They are what we call “little starter homes” in the Midwest and Southeast U.S., ranging in value from $25,000 to $50,000, with the average home price being right around $40,000. They are in the lower pricing band, making them the most affordable housing within the core rental market. What’s so attractive about this market? The home values are extremely stable, they’re easy to rent, and in general, they have a very limited downside.

Not only will you pay zero capital gains tax when you purchase your Guardian Homes, but you will gain safety through greater diversification within one of the most profitable housing categories in the country, while most likely doubling your return. All this, without ever being bothered by another tenant complaint, property manager phone call, vacancy notice, or “my girlfriend left so I have to move out” story again. Isn’t it liberating to think of solely being an investor, not a landlord?

The IRS imposes some restrictive timelines on a 1031 Exchange (which you won’t have to worry about with Guardian!): Once you initiate your exchange, you only have 45 days to identify another investment property/properties and 180 days (starting concurrently with the 45 days) to close. Plus, the new property must equal or exceed the value of the property you sold in order to completely defer your taxes.

As you can imagine, it is not easy out on the open market to identify and negotiate an agreement with all the parties involved for an appropriate exchange within a 45-day window and make sure it all closes in 180 days. If you miss either deadline, the 1031 Exchange is null and void and so are your tax savings. Fortunately, purchasing Guardian Homes eliminates the challenge of working within these timeline restrictions.

Let’s go back to our example scenario and assume that you bought your property for $150,000, and today you can sell it for $400,000. That is going to result in a hefty capital gains tax bill if you don’t do an exchange. Also, keep in mind that you will have to recapture all of the depreciation you have written off throughout the last 20 years which means even more capital gains taxes. Yuck!

Upon the completion of your Guardian exchange, you will own a $400,000 pro rata share of all the assets in Guardian and receive, on a monthly basis, your pro rata share of Guardian’s net profits. You now have tremendous diversification across all the homes in the fund — hundreds of homes in multiple cities — not just your purchased Guardian homes, or even worse, not just the single home you used for the exchange.

When you purchase/exchange your home for individual homes, they will each be titled in your name. This assures compliance with the 1031 Exchange requirements, making the exchange tax- and hassle-free.You won’t have to think about the individual homes again, because, at this point, you will be an investor in the fund, not a landlord for any of your Guardian Homes.

Not only will you no longer be dealing with landlord hassles and not have to pay capital gains taxes, but you are almost sure to make more money with your Guardian Homes. Investors often have a lot of equity tied up in property that’s not generating the return that it once did, and more often than not, selling a property and performing an exchange for Guardian Homes will, at a minimum, double your current return.

Just the other day, I had the opportunity to crunch some real-life numbers with a gentleman (let’s call him John) who owns a rental home in Reno. John owns his rental free and clear. The home is valued at $400,000, and he collects $1,800 a month in gross rent, netting about $1,500 a month in profit. That is $18,000 in net profit or cash flow per year.

Compare that to owning Guardian Homes within the Guardian fund. If John were to take his $400,000, he could purchase 10 homes, each generating $570 in gross rent per month, which comes to $5,700 per month for all 10 homes. That’s 316% more than his home in Reno! Using a conservative net return for Guardian of 10%, those 10 homes would produce $40,000 per year in cash flow, 222% more than his Reno rental. As you can see, it would more than double John’s current net. With the Guardian homes, John will have greater diversification, will be in a safer asset class in housing, and he’ll have zero landlord hassles.

To be fair, the Reno home could appreciate, but it would be pure speculation. Plus, in order to match the net return that Guardian would produce for him, John’s home would have to achieve a yearly appreciation of 5.55% – a difficult number to reach and maintain year after year. Although no return is ever guaranteed, Guardian’s return is consistent and contains no real guess work. When we compared those hard facts, it was a no-brainer for John. I think it was “aha” moment for him, seeing the numbers in black and white.

Each individual situation is different, of course, but we see this scenario most of the time. If you have a property you’re thinking of selling, we would be happy to help you run the numbers for your own comparison.

Those are the “nuts and bolts” of how a 1031 Exchange works – more specifically, how it works with Guardian Homes. I’m sure some of our current landlord readers have other questions brewing, so I’m going to answer what I believe are a few of them. As I touch on these other possible situations, you’ll see even more benefits and flexibility in the Guardian Homes 1031 Exchange.

Let’s say you decide to exchange your $400,000 home for 10 Guardian Homes. What if, down the road, you wanted to sell all or some of the homes, or do another full or partial 1031 Exchange?

The simple answer to any and all of these scenarios is, “Yes, you can.” Since your name is on all the titles, you can basically do whatever you like. If you decide to sell a few of the homes and NOT do a 1031, you’d only be required to pay gains taxes for the portion you sold. You can also do a 1031 Exchange on each home, one at a time, or in any multiple you choose. These options can give you incredible flexibility compared with only having one property in an “all or nothing” type of scenario.

Not all landlords own their property outright. How does the exchange work if you still owe money on it?

Let’s say you sell your property for $400,000, but you still owe $100,000. In a 1031 Exchange, you are required to purchase $400,000 of investment property, so normally you would take out another loan on the new property or come up with $100,000 cash out of pocket. However, with Guardian, you would buy $400,000-worth of Guardian Homes and Guardian would provide seller financing by carrying a note for $100,000. This legally satisfies the 1031 for the full $400,000 by the fact that you own the homes in your name. You will receive a K-1 at the end of the year showing your net income with the benefit of depreciation. As far as your equity investment, you would be invested at the $300,000 level and would collect your pro rata share of net profits every month. This would be no different from any other investment where you were invested at $400,000 with a $100,000 loan.

Let’s say you own a property called Big Building, LLC with three other partners at an equal ownership of 25% each. You all agree that you want to sell the property. The problem is, you want to do a 1030 Exchange, but your partners don’t. Can it still work?

Yes. First, you’ll need to keep Big Building, LLC open for two years after the sale. You will have done a 1031 Exchange with your portion, and you will own the commensurate number of Guardian Homes titled in Big Building, LLC’s name. The other partners will no longer own anything in Big Building, LLC, but they will still receive K-1s from the LLC for the next two years showing no income or taxable event. After two years, you will be able to change to a new LLC with you as the sole member. The homes will be re-titled in your new LLC’s name.

There’s one more thing we haven’t addressed yet — the elephant in the room: Won’t you eventually have to pay taxes on the capital gain?

Although a 1031 Exchange is “tax-free” at the time of the exchange, it is actually deferred, so yes, you will have to pay taxes on the final sale when you decide not to do another 1031. However, one brilliant move could actually relieve the tax burden for real and for good: You can leave the properties in your estate and never sell them. Your beneficiaries, including your spouse, will inherit the properties on an adjusted cost (based on the property value at the time of inheritance), which will eliminate taxes at that point in time. Now, that is a fun way to legally “stick it” to the IRS in the end!

Being even more of an investor and 100% less of a landlord through a 1031 Exchange with Guardian Homes could free up hours of your time and provide greater financial resources to enjoy more of the things you’ve worked so hard for.